How Sushmita selected her first mutual fund

The other day, I met a cousin of mine - Sushmita. Sushmita is 30, works as an HR manager in an IT firm, earns well, and lives in Bangalore. At dinner, Sushmita casually mentioned something about feeling overwhelmed about money.

As I asked my cousin gentle probing questions, I realised my uncle wanted to gift her a sizable chunk of money from his retirement bounty. Also, she has wanted to invest a part of her salary regularly.

My cousin understands the value of mutual funds and knows that she should start a systematic investment plan (SIP) for her salary-driven investments. To her credit, she is also aware of the strategy to stagger payments when investing a lump sum.

"So what's stopping you?" I asked.

"I want to pick the 'best fund' da !" she exclaimed.

That was it. She didn't know how to select her first mutual fund.

So, here's what I told her.

There are no 'best' funds
Determining the 'best' mutual fund can be intimidating and subjective. But all you have to do is identify a few that suit your needs.

That said, even this can seem daunting because there are so many options and multiple factors to consider.

You must consider your individual financial goals, risk tolerance, and investment timelines and pick a suitable mutual fund accordingly.

So, I taught Sushmita a basic framework using which she could choose a suitable mutual fund for herself.

Identifying financial goals
Sushmita is 30, so her goals include both growth-oriented goals like retirement and children's education fund. She also has capital preservation goals like a downpayment on her house or money for a health emergency.

For her growth-oriented goals, I made her select an equity-oriented mutual fund. While volatile in the short term, these funds tend to provide better returns over the long haul.

For her capital-preservation goals, I made a recommendation for a debt mutual fund . These funds carry less risk and provide steady, albeit smaller, returns.

Because she understands her goals well, we also figured out how much money she should invest in each of these funds respectively.

Understanding investment comfort
Sushmita is a first-time investor, so obviously, she's a little risk-averse.

A good idea for Sushmita is to begin with aggressive hybrid funds for her long-term goals. These funds have about two-thirds in the equity component and the rest in the debt component.

They are also less volatile and provide stability. As a result, they balance risk and return well over a long time.

But for other investors with some experience in the market, we recommend you look at pure equity funds, provided you are good at handling market swings and have an investment horizon of more than five years. While these funds carry high risk, they often give better returns over the long term.

Determining investment horizon
Investment horizon is the length of time that you can invest before you need to withdraw your money.

For instance, Sushmita's retirement goal is almost 20 years away (goals longer than five years are considered long-term goals). So, she can invest heavily in equity mutual funds.

She also needs to account for inflation over these years, another reason equity mutual funds were ideal. These funds will allow her to gain high returns and recover from market fluctuations over time.

On the contrary, her short-term goal is to make the down payment on the house. This means that she will need this money within the next three years. So, she should invest in safer, low-return funds.

The decision
So finally, Sushmita began with a good 'aggressive-hybrid' fund for her long-term investment goals. On the other hand, for her short-term goals, she chose a 'short-duration' fund to pay the down payment in around two years.

Also, Sushmita should review her portfolio after three years, in which she will have gained sufficient experience in the market. It will allow her to make changes like diversification or moving to pure-equity funds over time.

Your takeaway
While solving my cousin's dilemma about choosing the best funds, I realised that this framework applies to all of us new to investing. All we have to do is ask ourselves the three crucial questions and then pick the right mutual fund.

To conclude
Once you have shortlisted your first investments, all you must do is refer to our Analysts' Choice feature. It will help you in selecting top-performing funds in respective categories.

Suggested read: A practical guide to choose the 'right' mutual fund